Download Financial integration in the four Basins: a quantitative comparison

Financial integration in the four Basins: a quantitative comparison
Sergio Alessandrini1
Preliminary version
June 4, 2010
Paper presented at the International Seminar “The four sea basins and the global economy: do the
EU 4 freedoms work?”, ICPS Kyiv, Ukraine, June 9-10, 2010
Abstract
This paper presents some stylized features of the financial integration of the four basin regions
(Baltic Sea, Black Sea, Caspian Sea and Mediterranean Sea regions) and discusses the
developments, trends and features of the IIP in the regions. Chapter 3 identifies the gaps in them,
distinguishing the EU e non-EU members and provides an overview of the asymmetries and the
convergence as a result of the financial integration in the different markets. After the review the
trends the final chapter points to areas where further efforts are needed for achieving greater
regional integration.
JEL Classification
Keywords: international financial integration, convergence, asymmetries, current account openness,
FDI, financial development, portfolio investment
1
University of Modena and Reggio Emilia, Italy
[email protected]
1. Introduction
Since the 1990s the European Union undertook a series of reforms in order to complete the full
liberalization of capital transactions among the member states and with third parties. The aim was to
realize the full financial integration of the European capital markets along the same principles of the
common market for good and services2. In 2004, the Wider Europe and the ENP projects proposed
a “comprehensive prudential regulatory framework for the financial services area”3, that would
reinforce the undergoing benefits of the capital account liberalization in the partner countries.
In combination with the completion of the internal market and the implementation of the EMU, the
conceptual framework suggest, that over time, more financial integration adds to the stability of
financial markets and help enhance the overall economic performance.
One of the main benefits of financial integration is the development of the financial sector.
Financial markets become deeper and more sophisticated when they integrate with external
markets, increasing the financial alternatives for borrowers and investors4.
This paper takes a comparative look at the patterns of international financial integration and
addresses the thematic issues with the aim to benchmark the four basin regions. It is well known
that they represent four groups of countries with different institutional and economic characteristics.
In particular the regions are the following:
The Baltic Sea region: EU: Estonia, Latvia, Lithuania, Denmark, Finland, Sweden, Germany,
Poland; Non EU: Russia, Belarus
The Black Sea region: EU. Bulgaria, Greece, Romania; Non EU: Turkey, Georgia, Russia, Ukraine,
Moldova, Armenia, Azerbaijan
The Caspian Sea region: EU: none; Non EU: Iran, Azerbaijan, Russia, Kazakhstan, Turkmenistan,
Georgia, Armenia, Turkey, Uzbekistan
The Mediterranean Sea region: EU: France, Greece, Italy, Slovenia, Spain, Malta, Cyprus; Non EU:
Turkey, Lebanon, Syria, Israel, Egypt, Jordan, Libya, Tunisia, Algeria, Morocco, Bosnia and
Herzegovina, Croatia, Montenegro, Albania, Serbia, Macedonia.
There are some overlapping among the groups: Russia and Turkey have borders in three basins,
while Azerbaijan is in two basins.
2. Two questions
The first question is related to the theoretical models of financial integration and the empirical
evidence.
The standard economic theory suggests that liberalisation of capital flows, in particular long-term
capital flows, and financial development are important policy instruments, because they provide a
favourable support for the integration of neighbouring countries on a regional scale. In this regard,
capital flows play a crucial role, in terms of fostering accelerated growth, technical innovation and
2
European Commission (1996).
European Commission (2004), pp. 15-16. “It will be key to the creation of business and the promotion of investments
that these countries ensure that companies are able to operate on a level playing field. In combination with the above
measures, access to European financial markets should, over time, add to the stability of partners’ financial markets and
help enhance their overall economic performance. The further liberalising of capital movements will provide new
opportunities.”
4
For a critical analysis of the benefits of capital liberalisation see STIGLITZ (2004), in particular the different impact
between FDI and short-term capital flows.
3
1
enterprise restructuring5. In recognition of these potential benefits, governments of many countries
have undertaken widespread capital account liberalization over the past quarter-century.
In the 1990s, capital account liberalization was an important part of the market reforms introduced
by governments in the transition economies6. Because of the capital account liberalization, these
countries attracted large amounts of foreign capital and the main benefit was the development of
their financial system, which involves more complete, deeper, better-regulated financial markets
and more credit to foster the transition and the economic growth.
There are two main channels through which financial integration promotes financial development.
First, financial integration implies that a new type of capital and more capital is available to
neighbouring countries. Among other things, new and more capital allows these countries to better
smooth consumption, deepens financial markets, and increases the degree of market discipline.
Second, financial integration leads to a better financial infrastructure, which mitigates information
asymmetries and, as a consequence, reduces problems such as adverse selection and moral hazard7.
In brief, according to the theoretical predictions, the main benefits of financial integration with
foreign markets are:
(a) the possibility over time of stabilizing the consumption profile of individuals at less cost than is
involved in the case of a capital account with restrictions, complementing domestic saving efforts
with foreign savings, and thereby accelerating investment and growth;
(b) the possibility of diversifying risk by acquiring positions in assets and debt the risks of which
differ from what is available on the domestic market, reducing the volatility of domestic revenue
and consumption;
(c) the possibility of supplementing domestic investments with foreign investment, using new
technologies to exploit and manage resources;
(d) facilitated access, via foreign investment, to new markets where the comparative advantages of
productive sectors in transition countries can be taken advantage of; and
(e) the possibility of delivering more efficient and complete financial services for domestic users by
opening the field to competition by foreign players8.
3. Financial integration in the four basins
3.1 The evidence and the practices
Liberalization of capital flows is a general feature in almost all countries of the four basins. During
the last two decades, most neighbouring economies undertook a series of market reforms and tried
to adapted policies of a high degree of capital account openness. Some of them in the Black and
Baltic Sea basins became full members of the EU, having adopted all the acquis communitaire.
In the other neighbouring countries, in particular the Mediterranean countries, as capital controls
have been progressively eased in recent years, the financial integration has increased significantly9.
5
PRASAD, Eswar S., et al. (2003); EDISON, H.J, et al (2004).
Capital account liberalization is considered an important precursor to financial integration. See KOSE, M. A., E.
PRASAD, K. ROGOFF and S.-J. WEI (2006).
7
SCHMUKLER, Sergio L. (2004), “Financial Globalization: Gain and Pain for Developing Countries,” Federal
Reserve Bank of Atlanta Economic Review, Second Quarter. But also the criticism of Stiglitz (2004) on short-term
capital flows cannot be neglected.
6
8
MASSAD, Carlos (2000),
2
Capital liberalization, combined with market deregulation, has created many opportunities for these
transition economies in term of economic growth and employment. The savings of the EU
economies had the possibility to finance investments in the neighbouring partners, to differentiate
the risk and attain a more efficient allocation of capital. However, capital outflows can also have
less desirable side-effects. In the context of incomplete structural reforms, international capital
flows carry considerable risks and may magnify the underlying macroeconomic and structural
weaknesses.
The other neighbouring countries liberalized their capital accounts later in the nineties or not at all.
One important feature of the liberalization process in the neighbouring countries was that the
countries tended to liberalize inflows before outflows. This approach was mainly attributable to the
initial uncertainty about the success of the political and economic transformation.
The initial fears of the policy-makers, that high inflation and depreciating currencies might trigger
capital flight, faded out as the as the macroeconomic stabilization significantly progressed in the
decade of transition, and from the second half of the 1990s inwards capital inflows caused more
difficulties than potential outflows. Therefore in Commonwealth of Independent States (CIS)
economies, the capital account openness has been slower than CEE economies. The progress of
capital account openness started in these economies after 2000 and is still incomplete in most CIS
economies. Although Azerbaijan, Kazakhstan and Tajikistan have higher level than the other among
CIS, the levels are not enough to growth for these economies.
In brief, the empirical evidence shows that capital flows are influenced by many factors:
liberalisation of international capital transactions; regulatory reforms of capital markets;
improvements in the macroeconomic performance of countries; rapid progress in communication
technologies, and privatisation and structural economic policies in countries.
The second question is: How open are the capital markets of these countries and how is progressing
the financial integration among the basins.
The definition of “financial integration” consider two broad categories of indicators: Quantity or
volume-based indicators are used to investigate the extent to which investors have internationalised
their portfolios. In financially integrated markets investors will increase their holdings of nondomestic assets in order to benefits from the international diversification.
Instead, price-based indicators measure discrepancies in asset prices on the basis of their
geographic origin. In a perfectly integrated market, prices of assets with similar characteristics
should be the same or at least largely influenced by common area factors.
In this paper we approach the comparison using volume-based indicators
3.2 The domestic perspective
Financial market integration plays a special role in neighbouring countries which are all transition
or emerging countries. It is widely known that the financial market is one of the most important
elements of the transition as it is the central institution for transforming savings into investments
and thus generating long-term economic growth.
Previous studies have shown that the financial integration can be analysed from two different
perspectives.
9
MÜLLER-JENTSCH, Daniel, (2004); LAGOARDE-SEGOT, Thomas and Brian M. LUCEY, Brian M., (2008)
3
From the domestic perspective, financial markets in neighbouring countries still remain
underdeveloped and rudimentary, which is clearly shown in Table 1.
The Baltic Sea basin has the highest average level of GNI per capita compared with the other
regions, followed by the Mediterranean Sea basin. The difference between EU and Non EU member
states, measured by the standard deviation, is also lower in the Baltic Sea basin then in the
Mediterranean, with the highest differences in the Black Sea basin.
The picture remains essentially the same if we look at the two other indicators of financial
development: the Market capitalisation of the listed companies and the Share of lending to private
sector.
Both indicators show a small convergence between EU and non-EU members, with again the
highest performance for the Baltic Sea which precedes the Mediterranean basin. During the decade,
market capitalisation increased to 39% from the low 7,5% in 2000, with the highest level in the non
EU economies of the Baltic region, while for the EU economies the highest level is scored in the
Mediterranean basin.
Again, comparatively, the Mediterranean Sea basin confirms the highest indicators of financial
market integration, with more than 48% of lending to private sector in non EU economies, that is
relatively larger than the share in Baltic and Black Sea regions (on average less than 35%).
In this context of large differences in volume and in scale, the international financial integration has
provided additional resource to supplement domestic savings and increased the competition in
domestic financial systems. On the way to adapt their rules and regulations to the new environment,
these countries faced several problems that concern not only the development of a national financial
intermediation system but the economy in general.
Some of these problems have an institutional nature, as the low profitability of the economy and its
industries, the lack of corporate and economic culture or the inadequate protection of the minority
shareholder rights during the privatisation phase. And on more than one occasion, the
monopolisation of some sectors of the economy had a significant and negative influence in the
financial markets.
Figure 1: Domestic financial integration
Domestic credit to
private sector (% of
GDP)
2000
2008
55,6
105,2
11,1
34,9
GNI per capita PPP
Market capitalization of listed
companies (% of GDP)
EU Baltic
Non EU Baltic
2000
16.790
5.615
2009
27.051
13.790
2000
72,6
7,5
2007
69,0
58,0
2008
27,0
39,4
EU Black Sea
Non EU Black Sea
9.357
3.510
17.683
8.337
32,0
11,2
55,5
36,2
17,7
16,0
22,2
11,4
68,8
35,9
EU Caspian Sea
Non EU Caspian Sea
0
3.758
0
8.582
0,0
6,3
0,0
25,6
0,0
13,6
0,0
10,9
0,0
21,2
EU Mediterranean Sea
Non EU Mediterranean Sea
19.297
5.524
27.990
11.144
66,6
12,3
91,7
53,9
30,4
27,7
94,3
35,9
138,5
48,9
Euro Area
23.275
33.193
86,9
85,0
37,9
97,9
126,4
4
3.3 The international perspective
From an international perspective the main contribution of integration is the source of financing,
with the traditional tripartition of international capital flows: (1) Foreign direct investment (FDI)
which are flows between firms and their foreign subsidiaries or foreign partners and may be the
result of earnings of the same foreign subsidiary that are retained abroad; (2) Portfolio investments,
which are private transaction in equity securities and debt securities between banks and financial
intermediaries; (3) Debt instruments, which are financial flows between financial intermediaries and
firms and governments which supports trade and investment activities.
All international trade in financial assets, in the various forms of cross-border portfolio holdings or
the internationalization of production via foreign direct investment, suggest an ever increasing
international economic interdependence within the four basis that will be measured by volume
based indicators.
For the presentation at this seminar we use the database of Lane and Milesi-Ferretti (2000-2007)10
with the update for the year 2008. According to the authors’ methodology, international financial
transactions are divided into broad categories: portfolio equity investment, FDI, foreign exchange
reserves, and debt (which includes portfolio debt securities as well as other instruments, such as
loans, deposits, and trade credits). The net external position, given by the difference between total
external assets and total external liabilities, measures the net creditor or debtor position of the four
regions vis-à-vis the rest of the world. The net external position is similar to the IMF definition of
“Net International Investment Position” which is the measure of the cross-border financial net flows
(over time) plus the changes in the value of the holdings of these assets. We used the Lane MilesiFerretti database because the IIP statistics do not yet cover all neighbouring countries of the four
basins.
From the elaboration of data we can deduce a number of broad trends or stylized facts.
3.4 Two big trends
The pattern of international financial integration have changed significantly. The direction of the
EU-Neighbouring partners capital flows is no longer a central element of the European external
relations. There are some countries with the highest assets close to the highest liabilities, resulting
in almost flat net position and others with increasing unbalances, positive or negative. The
traditional characterization of capital-rich and capital-poor no longer follows the EU's external
borders, so as to emphasize the traditional separation between the North and the South that has
governed the debate in the seventies. The role of financial intermediation will hold for both,
transferring financial resources or “swapping” assets and liabilities in order to diversify the risk.
In presenting the data, we divide countries into four groups representing the four basins. In addition
in order to denote the EU members within each group, we subdivide the 4 Seas groups in EU e non
EU. The separation is necessary in order to remark the different institutional character of the
country.
The indicators follow the definition proposed by Lane and Milesi-Ferretti (2003)11 for measuring
the International Financial Integration as a stock to GDP ratio:
IFI = (FA + FL) / GDP
10
The database is available on line at http://www.philiplane.org/EWN.html
LANE, Philip R., and MILESI-FERRETTI Gian Maria, (2001); LANE, Philip R., and MILESI-FERRETTI Gian
Maria, (2003).
11
5
NEP = (FA - FL) / GDP
where FA (FL) denotes the stock of external assets (liabilities). This ratio is a volume-based
measure of international financial integration. The indicator can also be expressed as a difference
between gross foreign assets and foreign, as defined by the net external position, and GDP.
Figure 2 plots the IFI ratio for the four groups of countries over the period 2000-2008. Most of the
adjustment of the liberalization of the capital accounts were implemented rather quickly in the
nineties, and in share terms, the dynamics of capital flows had already stabilized.
For the non-EU economies, we notice a deceleration of the financial integration that stops in 2004
with a resumption of bilateral flows that led these countries to overcome the initial levels of
integration. The financial crisis of 2008 has dissolved the progress achieved in a decade. The
development is however not comparable to with the strength and speed of financial integration
within the Union, with a ratio three time higher than the GDP.
This is, of course, consistent with the theory of financial harmonisation pursued by the Union.
Therefore, international financial integration has increased markedly, particularly among the EU
economies. While the trend toward increased international asset trade has been visible since the
early 1970s, it has accelerated since the mid-1990s with the implementation of the three stages of
the EMU (Economic Monetary Union). Total assets of the Euro Area increased from 6.590 billion
USD to 19.239 billions in 2008. The IFI ratio increased from 210 to 300% of GDP. In the EU, the
increase in cross-border asset holdings has been strong for both debt and equity instruments (the
latter including FDI and portfolio equity) and in other debt instruments. According to the sources,
EU Mediterranean countries remain the main recipient of international investments, with the lowest
level for the three Black sea EU countries.
In the non-EU economies, there has also been an increase in cross-border equity holdings, but the
overall stock of debt instruments on GDP (debt assets and debt liabilities) has been decreasing since
year 2000. The non EU Baltic economies have the highest IFI index for FDI and Portfolio equity
instruments, 90% of GDP in 2007, while the lowest 50% is reported by non EU Mediterranean
countries. In addition, data seems to suggest that all four Neighbouring regions account for a
smaller share of debt instruments.
Figure 2: International Integration Index (Gross position)
a) Gross capital flows
Financial Integration (FA + FL / GDP) - EU countries
Financial Integration (FA + FL / GDP) - non EU countries
450,0
400,0
M editerranean EU
400,0
350,0
Euro Area
350,0
300,0
Baltic EU
300,0
Euro Area
250,0
250,0
200,0
M editerranean No n EU
Baltic Non EU
200,0
B lack EU
150,0
150,0
Caspian No n EU
100,0
100,0
B lack No n EU
50,0
50,0
0,0
0,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
b) Gross Portfolio Equity and Foreign Direct Investment
6
Financial Integration (FA & FL equity and FDI / GDP) - EU
countries
Financial Integration (FA & FL equity and FDI / GDP) - non EU
countries
160,0
160,0
140,0
140,0
Euro Area
120,0
M editerranean EU
Baltic EU
120,0
100,0
Euro Area
100,0
Baltic Non EU
80,0
80,0
60,0
60,0
B lack EU
B lack No n EU
40,0
40,0
M editerranean No n EU
Caspian No n EU
20,0
20,0
0,0
0,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
c) Gross Other Investment (Portfolio Securities Debt and Other Investment)
Other FA + FL / GDP - EU
Other FA+FL / GDP - non EU
300,0
250,0
250,0
200,0
Baltic EU
200,0
Euro Area
Euro Area
M editerranean EU,
150,0
150,0
B lack EU
Baltic Non EU
100,0
100,0
B lack No n EU
M editerranean No n EU
Caspian No n EU
50,0
50,0
0,0
0,0
2000
2000
2001
2002
2003
2004
2005
2006
2007
2001
2002
2003
2004
2005
2006
2007
2008
2008
Clearly, factors such as the increase in trade linkages, the reduction in capital controls, domestic
financial deepening, advances in telecommunications, and the increased availability of information
are important in driving the acceleration of international financial integration in the four regions,
but the trends (in particular those referring to other investments) underscore the deep difference that
separates the European economy and that of neighbouring countries.
However, the structure of capital flows has improved, in the sense that FDI has become the most
dynamic source of net capital flows. The non-EU Baltic countries are taking advantage on the
Mediterranean region, when considering the relative size to GDP, and they are even more integrated
than the EU Black sea countries. FDI seems the most desirable type of flows, in that it tends to be
more long-term and less easily reversible, as well as often incorporating new technology and other
know-how. The announcement of the ENP project in 2004 has also contributed to an acceleration of
the FDI transaction in all regions.
But there is another fundamental trend concerning the convergence effect of a deeper integration.
The EU imbalances have increased during the 2000s, while for the non EU partners the
convergence was the main effect of the European integration project until the disruption caused by
the financial crisis in 2008. Non EU Mediterranean decreased their net debt position (although we
can notice a reversal in 2008), while the non EU Baltic region shifted from a net positive position to
a negative one in 2007. The evolution of the neighbouring countries differs from the other emerging
market economies, which suffered the contraction of external capital flows during the same period.
In this perspective the favourable expectations of the international lenders to the Baltic region, and
Russia in particular, differ from the relative contraction of external financing (in particular bank
loans) affecting the Southern Mediterranean region. These convergence patterns were interrupted by
the financial crisis of the summer 2008. In fact, the net creditor position in 2008 in the three regions
(Baltic, Caspian and Black sea) is essentially due to the contraction of portfolio liabilities of Russia.
7
Instead, for the EU economies the imbalances increased, with a positive net position for the Baltic
region (net position of Germany) and a deterioration of the Black Sea region (Greece) and
Mediterranean Region (Spain).
Which are the largest creditors and debtors, relative to their GDP levels? Even though richer
countries tend to be creditors (Germany, with a net position of 25% of GDP in 2007 - 7% in 2001
and France, with a net creditor position of 10% of GDP), the correlation is less evident. Russia has
been net creditor before 2004 and becomes net creditor again in 2008. Syria, Iran and Libya are
creditor with net foreign credits higher than 30% of GDP (230% for Libya). In the Caspian region
the foreign assets accumulated by the governments during the decade of high oil and gas prices now
exceed the total foreign debt and inward FDI in countries like Azerbaijan, Turkmenistan and
Uzbekistan, with an average net external position higher than 30%. Iran too, has a net positive
position.
Several neighbouring countries have successfully build up foreign assets and funds that help
mitigate the impact of the economic setback in the industrial countries, but the longer-term goal of
economic diversification remain elusive. This is partly because these countries in the Mediterranean
and Caspian basin are dependent on wealth from natural resources and they lack of the sound
institutional framework that would support the creation of a more diversified economy.
France become net debtor in 2008, with a remarkable contraction of the value of FDI. The EU
largest net debtors are Spain, with a NEP index higher than 80% (from a 24% in 2000), Greece
(more than 100%) and Italy (21%). Indeed, in addition to the level of development (measured by the
GNI), several other factors—including demographics, the size of public debt and FDI, and natural
resources—influence significantly the net external position of the four basin.
From the perspective of private capital flows the asymmetries between EU and non EU have
increased, with a negative net external position higher than 35% of GDP in all regions and with
only five capital exporting EU countries (Denmark, Germany and Sweden) in the Baltic Sea, Italy
and France in the Mediterranean Sea. Among the neighbouring countries only Libya is a net
investor (Portfolio Investments). For the non-EU Mediterranean countries and Baltic region, the
downward trend in their external position was reversed in 2008, primary because of a deterioration
of Russian Federation (contraction of inward FDI) and the stability of the Caspian ad Black sea.
For the Baltic the improvement in 2008 is due to the contraction of foreign investments in the same
year.
The comparative look for the net debt position (debt assets less debt liabilities) shows the
convergence to lower level of external exposure, around 10% of GDP, while in 2000 the non EU
Mediterranean countries were exposed by more than 30% of their GDP. Here, the shift from
indebtedness to FDI has been made possible by the instruments of the first pillar of the
euromediterranean partnership within the Barcelona Process. Instead, the financial integration
within the EU has encouraged a credit boom and over-borrowing which have increased the
unbalances in the Black sea basin (Greece in particular and Romania), the Mediterranean (again
Greece and Spain), in contrast with the Baltic Sea basin that is near the balance.
8
Figure 3: Net External Position Index
a) Gross capital flows
Net Foregn Assets / GDP - EU
Net Foregn Assets / GDP - non EU
20,0
20,0
Baltic EU
15,0
Baltic non EU
0,0
10,0
Euro Area
5,0
0,0
-20,0
Euro Area
-5,0
Mediterranean EU
Caspian non EU
-40,0
-10,0
-15,0
-60,0
-20,0
Black non EU
Black EU
-25,0
Mediterranean non EU
-30,0
-80,0
-35,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
-100,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
b) Gross Portfolio Equity and Foreign Direct Investment
Net PF + FDI / GDP - EU
Net PF + FDI / GDP - non EU
10,0
0,0
0,0
-5,0
Euro Area
-10,0
M editerranean EU
-10,0
Euro Area
Baltic EU
-20,0
-15,0
-30,0
-20,0
-40,0
Caspian No n EU
Baltic Non EU
-25,0
-50,0
M editerranean No n EU
B lack EU
-30,0
-60,0
-35,0
-70,0
B lack No n EU
-40,0
-80,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
c) Gross Other Investment (Portfolio Securities Debt and Other Investment)
Net Other FA / GDP - EU
Net Other FA / GDP - non EU
20,0
0,0
10,0
-10,0
Baltic EU
Euro Area
Baltic Non EU
0,0
-20,0
Euro Area
M editerranean EU
-30,0
-10,0
-40,0
Caspian No n EU
B lack No n EU
-20,0
-50,0
M editerranean
No n EU
-30,0
B lack EU
-60,0
2000
-40,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2001
2002
2003
2004
2005
2006
2007
2008
-70,0
3.5 Opportunities and risks for neighbouring countries
The large increase in cross-border equity and direct investment holdings and the shifting patterns in
international borrowing and lending in the non EU partners can be viewed as factors reducing the
vulnerability of the neighbouring markets to external shocks. Equity liabilities (including FDI) now
account for about 40% of total external liabilities as a whole, compared to 20% of EU countries. All
four regions have moved smoothly towards this goal by eliminating the initial differences. The
9
difference of 10 points of GDP in 2007 was reduced to less than 4 percentage points. Also with
regard to outward FDI the new opportunity is represented by the new investors in the Black Sea and
Caspian Sea basins, with an accumulated stock of FDI higher than 20% of GDP, a level similar to
EU.
Further, all neighbouring economies have dramatically reduced the share of debt to their external
liabilities to level well below the EU average, thus clearly reducing the risks of financial crises by
linking more closely the return on external liabilities to domestic economic performance. As can be
seen in figures 4, the financial crisis of 2008 reversed the good performance of the previous years.
Figure 4: Share of FDI and Indebtedness
a) Share of Other Foreign Investment over total Foreign liabilities
Share of other FL / Total Liabilities - EU
Share of other FL / Total Liabilities - non EU
90,0
90,0
80,0
80,0
B lack EU
Baltic EU
70,0
70,0
Euro Area
60,0
M editerranean EU,
Euro Area
60,0
50,0
Baltic Non EU
40,0
B lack No n EU
30,0
M editerranean
No n EU
Caspian No n EU
20,0
50,0
40,0
10,0
30,0
0,0
2000
2000
2001
2002
2003
2004
2005
2006
2007
2001
2002
2003
2004
2005
2006
2007
2008
2008
b) Share of outward FDI over total Foreign Assets
Share of FDI out - EU
Share of FDI out - non EU
35,0
30,0
Euro Area
M editerranean EU
Euro Area
30,0
25,0
B lack No n EU
25,0
Caspian No n EU
20,0
20,0
Baltic Non EU
Baltic EU
15,0
15,0
10,0
10,0
M editerranean No n EU
5,0
B lack EU
5,0
0,0
0,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
c) Share of inward FDI over total Foreign Liabilities
10
FDI in / Total FL - EU
FDI in / Total FL - non EU
25,0
45,0
Euro Area
M editerranean No n EU
40,0
20,0
35,0
Caspian No n EU
30,0
Baltic EU
Baltic Non EU
15,0
B lack No n EU
M editerranean EU
25,0
B lack EU
20,0
10,0
Euro Area
15,0
10,0
5,0
5,0
0,0
0,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
3.6 Stock market capitalization
In terms of their stock market capitalization, The Mediterranean and Baltic Sea Regions are in a
better position. Particularly, Egypt, Jordan, Morocco, Croatia, in the Mediterranean basin and
Russian Federation in the North show a clear upward trend between 2003 and 2007 (Figure 5).
Nevertheless, the stock market capitalization still remains considerably below the relevant quotients
of developed economies in Tunisia, Algeria, Turkey, Syria, Belarus and in the Caspian basin..
Because the stock market is of relevance in financing enterprises, further efforts especially to attract
foreign investors can be very important.
Figure 5: Stock Market Capitalization in the 4 Seas 2000-2008, in percent of GDP
Market capitalisation / GDP - EU
Market capitalisation / GDP - non EU
100,0
100,0
M editerranean EU
90,0
90,0
Euro Area
Euro Area
80,0
80,0
70,0
70,0
60,0
60,0
Baltic EU
50,0
50,0
M editerranean No n EU
40,0
40,0
Baltic Non EU
20,0
B lack EU
Caspian No n EU
30,0
30,0
20,0
B lack No n EU
10,0
10,0
0,0
0,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
3.7 Reserves
Finally, international reserves that are the liquid external assets under the control of the central
bank. Here we notice a great asymmetry between the EU and the non EU regions. Not only the
reserves-GDP ratios are ten time larger in non EU countries but the ratios increased substantially
during the decade, 30% of GDP in the Mediterranean basis and 35% in the Baltic region (Russia in
particular).
11
In a period of greater flexibility of the exchange rates it is debatable this huge accumulation of
reserves in line with the predictions of the buffer stock model (Adjustment costs, volatility of
foreign trade, exposure volatile short-term inflows of capital)12.
These reserves have a cost, a “social cost”, that Rodrik (2006)13 estimated trough the spread
between the private sector’s cost of short-term borrowing abroad and the yield that the Central Bank
earns on its liquid foreign assets. The estimated spread is 3 to 7 percent, a spread undoubtly very
high especially for capital scarce economies. Therefore, it can be suggested that the central bank
either curtail the size of reserves accumulation or invest the excess reserves for more profitable
returns in term of employment (Mediterranean basin) and growth (Baltic basin).
Figure : Stock of International Reserves in the 4 Seas 2000-2008, in percent of GDP
Reserves / GDP - EU
Reserves / GDP - non EU
14,0
40,0
35,0
12,0
Baltic Non EU
30,0
M editerranean
No n EU
25,0
10,0
Caspian No n EU
B lack EU
8,0
20,0
Baltic EU
6,0
B lack No n EU
15,0
4,0
10,0
M editerranean EU
Euro Area
2,0
5,0
Euro Area
0,0
0,0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2000
2001
2002
2003
2004
2005
2006
2007
2008
4. Conclusions
The experience of the South Mediterranean countries suggest that, despite the improvements in the
FDI inflows and in deeper financial integration to some countries (Morocco, Tunisia, Egypt,
Jordan) its sectoral destination does not always correspond to the real needs of the recipient
economies. Excluding privatizations and investments in oil and gas partnership concessions, foreign
promoters invested only 1% of GPD, and the results were disappointing when confronted with the
to stimulated local production capacity and to create additional employment and revenue.
Therefore the essential policy issue is not simply to deepen the financial integration into the global
market but how to build competitive and dynamic sectors and to improve the composition of the
exports along the competitive advantages that require continuous investment, especially in skills
and information.
Despite these weaknesses, foreign investors could increase chances for domestic enterprises to
realize trade and investment opportunities through partnership, networking and exchange of
information on best practices.
For understanding the factors behind the financial integration and the necessary policy measures,
one needs to look at the role of the various institutions in the financial markets, not only in the
markets for goods and services, which are the main interest of the FTA project.
12
CALVO, G. (1998); EDWARDS, S. (2004).
13
RODRIK, Dani, (2006).
12
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13
Biographical note
Sergio Alessandrini joined the University of Modena and Reggio Emilia (Faculty of Law) in 1991
and is currently Full Professor of Economics. He is member of the Steering Committee of FEMISE
(Forum Euro-méditerranéen des Instituts économiques ), Marseille. He Graduated in Economics
from Bocconi University (Milan, Italy) in 1972. He did post graduate studies in economics at
Chicago University (Dept of Economics) and Cambridge University (UK).
Professor Alessandrini is the author of some fifty publications and articles related to a wide range of
topics and international issues including European integration, economics of transition and foreign
direct investment.
He has been on the board of directors of the PhD programme at Bocconi University (Italy) and
Maastricht School of Management (Netherlands).
Also, he has served as President of the Economic programme Committee of the Lombardy Region
during 2000-2005, and is consultant of the European Commission and international organisations
for the Mediterranean and Centro Asian regions.
14